Madoff, Other Ponzi-Scheme Victims May Qualify for Additional Tax Savings this Year by Jeff M. Mutnik, CPA/PFS
Posted on March 20, 2017 by Jeffrey Mutnik
It has been eight years since Bernie Madoff was arrested and charged with operating one of the largest Ponzi schemes in history. Victims, who lost an estimated $17.5 billion in initial investment principal, have recovered 65 percent of those losses and have had the benefit of an IRS safe harbor theft-loss deduction that may still, to this day, uncover hidden gems of future tax savings.
Initial IRS Relief
In response to the devastating and widespread impact of the Madoff scheme, the IRS issued in 2009 a tax relief plan that allowed victims to make a safe-harbor election and claim theft-loss deductions for a portion of their initial investments of principal. Specifically, victims who invested directly with Madoff had the ability to deduct on their 2008 tax returns 95 percent of a computed amount of their initial investment, plus net income reported due to the investment in the scheme (phantom or not), less their withdrawals and any actual or potential recovery. Victims who invested through third-parties received a 75 percent deduction on that amount. After deducting the appropriate percentage of Madoff losses in 2008, many victims were left with a net operating loss (NOL) carryback to apply against their income for years 2005 through 2007. Unabsorbed carry backs could then be carried forward until the victims fully utilized the NOLs generated by their investments.
The Challenge Today
For some investors, the carryforward of net operating losses was fully utilized in recent years, leaving them with the question of how to treat their remaining losses of 5 percent and 25 percent in net unrecovered investment that was not deductible under the IRS’s safe-harbor provision.
Other investors were left with the dilemma of what to report in connection with any recovery amounts received through third-party efforts. These issues are often confounded and problems are compounded when investors switch tax advisors and fail to keep alive the discussion about Madoff losses. For example, with eight years past the original safe harbor election to deduct Ponzi scheme losses, a taxpayer may be unaware of any remaining NOLs to which he or she may be entitled; most people simply are not tracking these losses. The taxpayer who does not expect to recover the remaining five or 25 percent of previously un-deducted losses from the Madoff estate may report an additional theft loss that he or she may use to create an NOL to carry forward into the 2016 tax year and beyond.
The impact of the Madoff Ponzi scheme offers an important lesson for taxpayers to heed, especially when changing accountants. Because the tax code includes many provisions that can be carried forward or carried back to apply to additional tax years, it is up to the taxpayer to stay informed. Keeping old discussions alive with new advisors can ensure maximum tax efficiency and compliance as well as optimal use of tax benefits that taxpayers are entitled to use from year to year.
About the Author: Jeffrey M. Mutnik, CPA/PFS, is a director with the Taxation and Financial Services practice of Berkowitz Pollack Brant Advisors and Accountants, where he provides tax and estate-planning counsel to high-net-worth families, closely held businesses and professional services firms. He can be reached in the CPA firm’s Ft. Lauderdale office at (954) 712-7000 or via email at email@example.com.